IEA Commends Japans Commitment to Energy Security and Environmental Objectives but Advises More Focus on Economic Efficiency

(Tokyo) — 18 November 2003

“Major developments in Japan’s energy policy in recent years include energy market reform, ratification of the Kyoto Protocol and the implementation of an enhanced policy package to achieve the Kyoto target”, said Claude Mandil, Executive Director of the International Energy Agency (IEA) at the launch today in Tokyo of “Energy Policies of IEA Countries – Japan 2003 Review.” “But while energy security and environmental issues have been well addressed in Japan,” he added, “more needs to be done to improve economic efficiency, notably in the energy markets and the cost-effectiveness of government policies.”

Energy Security
Energy security issues are more critical for Japan than for most IEA countries due to its geographical location and limited domestic energy resources. Consequently, Japan is making great efforts to ensure security of supply. Oil stocks well exceed the 90-day obligation, while flexibility tools such as supply diversity and possibilities for fuel-switching, are used for natural gas. Policies to promote nuclear power and renewable energies further contribute to diversification. Despite this effort however, growing dependency on imported oil from the Middle East is still a concern. Other energy security challenges also exist. The disruption in gas supply from Arun in Indonesia showed a potential security threat as the share of gas is increasing in the fuel mix. The outage of TEPCO nuclear plants which began in September 2002 is another example. Lastly, increasing summer peak demand for electricity makes it difficult to match supply and demand in the summer season which is usually hot.

Nuclear Power
Nuclear energy is expected to play a vital role in achieving energy security and climate change mitigation in Japan. The government’s current Long-Term Energy Supply and Demand Outlook projects a 30 % increase in nuclear power generation by 2010. But this target has become more difficult to reach due to safety-related incidents and significant plant outages in recent years. The first challenge is to restore public confidence. Secondly, since the load factor of Japanese nuclear power plants is on average lower than in other IEA countries, the statutory and other outage periods should be shortened and their frequency reduced without compromising the level of safety. A third challenge is to ensure the role of nuclear power in liberalised electricity markets, a subject that has not been addressed in the recent debate on further market reform in the electricity sector.

Climate Change Mitigation
In June 2002, Japan ratified the Kyoto Protocol, with an undertaking to achieve a 6% greenhouse gas (GHG) emission reduction during the first commitment period. But Japan’s energy-related CO2 emissions actually rose by 11.2% between 1990 and 2001. Although Japan’s CO2 emissions per capita and per unit of GDP are lower than the IEA average, rising GHG emissions are one of the most important energy policy challenges in Japan. The path towards the target has been laid down in the government’s New Guideline for Measures to Prevent Global Warming published in March 2002.

Japan has developed an impressive range of policies to address rising CO2 emissions from energy use: energy efficiency standards over a range of equipment, voluntary building codes, labelling, growing support for renewable energy and conservation policies, as well as subsidies to encourage fuel switching. But, noting the rapid increase of energy demand in household and passenger transport sectors, some could be strengthened. Energy efficiency labelling could be extended to a wider range of appliances for example; building energy performance standards could be made mandatory for new buildings and extended to the refurbishment of existing buildings. It is questionable whether the aim of the Keidanren’s Voluntary Action Plan for stabilising industry’s emissions by 2010 will be met if industrial output recovers from the current recession. Since the marginal cost of domestic emission reductions is increasing, industry’s participation in the Kyoto flexibility mechanisms would be welcome, as this may reduce the cost of climate change mitigation.

Economic Efficiency
One challenge for policymakers is meeting objectives in a cost-effective way. Japanese energy policy includes a complex web of financial and fiscal incentives to encourage certain energy supplies and end-use technologies. But it is not clear how well these mechanisms are working individually or collectively. Japan should develop a comprehensive map of all the various incentives and disincentives: financial, tax, regulatory, R&D, etc., to determine their cost-effectiveness and rationalise these policy options for maximum impact and leverage.

Despite some recent falls, energy prices in Japan are still among the highest amongst IEA Member countries. To remedy this, the government has launched market reform, with the process most advanced in the oil sector, which has been fully liberalised. The industry is still in the middle of restructuring however and the utilization ration of refining capacity remains very low and the number of filling stations high.

Natural gas market liberalisation started in 1995 and 40 % of the market is now open. If measured in terms of the market share held by new entrants, little competition has emerged. The government has recognised the need for further action to fully capture the benefits of market reform and announced new measures, such as introduction of regulated third-party access (TPA) to the pipelines and promotion of negotiated TPA to the LNG terminals. While useful, their effectiveness must be closely monitored and corrective measures introduced promptly if competition does not develop. Expansion of the domestic gas network is essential to achieve wider use of natural gas. It would also enhance security of supply and competition.

In March 2000, the government opened 30% of the electricity market to competition and established regulated TPA to the networks. Some prices have fallen, but this seems to be mainly due to utilities’ passing onto customers cost savings arising from low interest rates on capital expenditure. Competitive pricing as a result of market liberalisation may also have had some impact. Since new entrants find it difficult to enter the market and little competition seems to have developed between the incumbents, the government has announced measures, such as evaluating TPA tariffs. While this is commendable, the proposal does little to address the fact that the incumbents are large and powerful companies with significant market power when compared to new entrants. Given the slow entry rate of new players, greater competition between the incumbents is essential. The effectiveness of the planned unbundling arrangements, the new “neutral transmission organisation” and the regulatory institutions should be ensured. If competition fails to develop, stronger measures such as establishing an independent national transmission system operator should not be precluded. The weak interconnection between most supply regions must be strengthened to facilitate competition and ensure energy security.

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